Risk & Compliance

Brokers Are in Auction-rate Cross-hairs

With FINRA probe of brokerages that sold the securities, focus may be shifting from the banks that created them.
Stephen TaubAugust 21, 2008

Some regulators appear to be shifting the focus in their investigations of abuses in the auction-rate securities market, concentrating more on brokerages that sold the securities, and less on the banks that created them.

On-site inspections of about 40 brokerages involved in the ARS market will begin next week, according to Bloomberg News, citing a person familiar with the matter. According to the report, the Financial Industry Regulator Authority (FINRA), which regulates nearly 5,100 brokerages, sent letters to the firms this month seeking detailed records.

On Wednesday, New York Attorney General Andrew Cuomo also said he had subpoenaed a number of investment giants, including Fidelity Investments, Charles Schwab Corp. and Oppenheimer Holdings Inc. in a parallel probe. “If downstream brokerages deliberately stuck their heads in the sand but continued to actively market these products to unknowing investors, that will certainly be relevant to our calculus of our firms’ culpability,” Cuomo’s office said in a letter to the Regional Bond Dealers Association yesterday, the news service also said.

Meanwhile, the Associated Press, citing a person close to Cuomo’s investigation, reported that the attorney general will intensify his probe, focusing on Bank of America Corp., Goldman Sachs Group Inc., and Deutsche Bank AG. Five banks have already agreed to billion-dollar settlements so far: Wachovia, JPMorgan, Morgan Stanley, UBS, and Citigroup.

According to Bloomberg, Cuomo said Merrill Lynch & Co., which has announced a voluntary buyback of ARS, must reach a settlement Thursday or face legal action. “If we don’t settle today, tomorrow at this time we’ll be in court,” Cuomo said. “At some point, enough is enough.”

FINRA’s probes are focusing on firms that haven’t yet settled with regulators and have the largest client holdings of ARS, according to the wire service. According to Bloomberg, FINRA is examining whether the companies conducted due diligence on the products, ensured that brokers understood them and explained risks to customers. The wire service also noted that investigators are examining the firms’ communications with banks that ran the auctions.

The regulator is demanding spreadsheets on bids submitted for the products and clients’ holdings, copies of training and marketing materials, and the firms’ risk analyses and the results of internal investigations, according to the report. It is also trying to determine whether phone lines on auction-rate trading desks were recorded. According to the Bloomberg report, Cuomo’s office said in its letter yesterday that brokers could be punished if evidence shows they sold the debt while ignoring signs the market was weakening.

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